By Jonathan Weil
Bank stocks have been up since Election Day. So have the tail risks.
The S&P regional banks index has gained 12% since Nov. 5, which is understandable. The industry is anticipating looser regulation and a relaxation of the requirements for how much capital banks must hold as a cushion against unexpected losses. Those developments may help earnings in the coming years.
Investors so far have been willing to look past the possible trade-offs. The aggressive tariff hikes floated by President-elect Donald Trump would be inflationary and could lead to higher interest rates and bond yields. For banks holding large amounts of long-dated, fixed-rate assets, such as Treasurys and government-sponsored mortgage bonds, that could mean greater unrealized losses as bond values decline, weakening their balance sheets.
Those are the types of losses that led to Silicon Valley Bank's failure in March 2023. Risks of this sort appear manageable for now, with the yield on 10-year Treasurys at 4.23%, slightly below where it was on Election Day. However, a return to 5% yields or higher could spell trouble again for some lenders.
Here's the rub: There's no telling how Trump's new administration would react if a large regional bank failed during his next term. Whatever views he may have espoused in the past, he may not know himself until he is tested with an actual live situation.
In general, the Federal Deposit Insurance Corp. insures deposits up to $250,000 per person, per bank, although some customers with multiple accounts may qualify for more. If a bank fails, depositors whose accounts are above the limit face potential losses.
Silicon Valley Bank's shareholders didn't get a government bailout when the lender collapsed. But its uninsured depositors did, as did those at Signature Bank when it failed the weekend afterward. A few days later, Trump in a video posted on his Truth Social account said, "There should be no bailouts."
In an interview later that month, Fox News host Sean Hannity asked Trump: "Would you have supported the bailout of Silicon Valley Bank?" Trump replied: "I wouldn't have supported the bailout. The bank would have to get along by itself and maybe they could have." The bank failed, he said, because "they stupidly bought long-term Treasurys," and "those Treasurys got crushed" when interest rates rose. (Actually, its biggest losses were on government-backed mortgage bonds, but the point is the same.)
There is virtually no doubt the government in a crisis would backstop uninsured depositors at the largest U.S. financial institutions, such as JPMorgan Chase and Bank of America, which have trillions of dollars of assets and official designations as systemically important. But what about a lender with $200 billion of assets, similar to what Silicon Valley Bank reported, or $100 billion, like Signature? Or $40 billion?
Nobody knows where the line is. Investors and uninsured depositors alike should take note.
The widely held assumption after Silicon Valley Bank's collapse had been that uninsured deposits would be protected at all costs, even at much smaller banks.
For its initial response, the government said Silicon Valley Bank depositors would be covered only up to the limits of federal deposit insurance. When Signature Bank failed two days later, spurring fear of bank runs elsewhere, the Biden administration quickly switched course.
Treasury Secretary Janet Yellen invoked an exception under federal law for systemic risk, allowing the FDIC to guarantee all the deposits of Silicon Valley Bank and Signature. She later told lawmakers that such rulings would be made on a case-by-case basis and could include smaller banks if there was a risk of contagion. Within months, the crisis had subsided.
There are 40 publicly traded U.S. banks where combined unrealized losses on loans and held-to-maturity bonds were equivalent to at least 50% of total equity as of their most recent quarter, according to data compiled by S&P Global Market Intelligence. Most had assets of less than $3 billion. Flagstar Financial, with $114 billion of assets, was just under the 50% threshold, at 49%. Flagstar until recently was known as New York Community Bancorp, which earlier this year looked like it could be on the brink and might even trigger a new regional banking crisis.
Industrywide, unrealized losses on held-to-maturity bonds were $310 billion as of June 30, the most recent data available, according to the FDIC, after peaking at $390 billion in the third quarter last year. The held-to-maturity label means the paper losses don't count on the banks' balance sheets, allowing them to report robust levels of capital when their assets, in reality, are worth much less. But when a bank finds itself needing liquidity, it can be forced to sell the bonds and crystallize those losses. Such losses were negligible before 2022 when interest rates began rising.
Customers with large deposits got a reminder recently that it is possible to lose money when their bank goes bust. First National Bank of Lindsay, a rural Oklahoma lender that last reported $108 million of assets, failed in October. The FDIC said it would make 50% of its customers' uninsured deposits available, with no guarantees beyond that. It was the first time since 2019 that a U.S. bank failed where uninsured depositors lost money.
Citing the example of First National, Rohit Chopra, the director of the Consumer Financial Protection Bureau and an FDIC board member, last month called for Congress to remove, or dramatically increase, limits on federal deposit insurance for payroll and other noninterest-bearing business accounts. As he put it, "big businesses putting their money in big banks enjoy free deposit insurance, and small businesses putting their money in small banks don't. This is fundamentally unfair."
It is also likely to remain the status quo. Customers keeping uninsured deposits anywhere but the largest too-big-to-fail banks should find other places to park their money if they can.
Write to Jonathan Weil at jonathan.weil@wsj.com
(END) Dow Jones Newswires
December 04, 2024 05:30 ET (10:30 GMT)
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